Gold: Hold it or fold it?

Peter Schiff is one of the few non-biased investment advisors (not committed solely to the short side of the market) to have correctly called the current bear market before it began and to have positioned his clients accordingly. As a result of his accurate forecasts on the US stock market, economy, real estate, the mortgage meltdown, credit crunch, subprime debacle, commodities, gold and the dollar, he has become increasingly more renowned.

It's starting to feel like we are part of a giant poker game against the US government, whose hand is the true condition of the American economy.

The government has become so good at bluffing that most people
feel compelled to watch how the biggest players in the game react
to determine their own investment strategy.

Unfortunately, this past month revealed that even pros like
Goldman Sachs have no idea what sort of hand Washington is really
hiding.

Goldman Bets Against Gold

A week into the government shutdown, Jeffrey Currie, head of
commodities research at Goldman Sachs, declared that gold would
be a "slam dunk sell" if Washington resolved the budget debate
and raised the debt ceiling. The call was based on an underlying
narrative that the US economy is experiencing a slow, but
inevitable, recovery.

Taking this recovery as a foregone conclusion, conventional Wall
Street analysts saw two clear choices for Washington. On the one
hand, Congress could reach an agreement, raise the debt ceiling,
and allow the recovery to continue. This would allegedly have
been the final nail in the coffin of the safe-haven appeal of
gold.

On the other hand, if no agreement were reached, the government
would have been forced to default on its debt. This would have
erased any signs of recovery and sent the economy spiraling back
into a terrible recession - while boosting the gold price.

Goldman reasoned that Washington would never allow the latter to
unfold and suggested investors prepare to short or sell gold.

While Washington did kick the debt can down the road as
predicted, gold rallied 3% on the news - the complete opposite of
expectations. That is, expectations outside of Euro Pacific.

Misreading the Signals

After seeing an investment theory crushed by reality, a rational
investor would take a moment to reexamine his premises. In
Goldman's case, this would mean second-guessing the conventional
belief in an imminent or ongoing US economic recovery.

Yet, the day after Washington reached an agreement, Currie
reaffirmed to Goldman's clients that his US economic outlook for
2014 is positive and that he believes gold faces "significant
downside risks."

Currie must not have wanted to muddy his message by acknowledging
that his original forecast was flat wrong. He did, however, hedge
his statements by acknowledging that the Federal Reserve would
likely hold off on tapering its stimulus until next year.

Major Wall Street investment houses have come to rely on the
investing public's short-term memory to skate by on these bad
calls. When the next forecast is issued, clients and subscribers
quickly forget that Goldman was blindsided by the Fed's taper
fakeout in September. [Read more about the taper fakeout in my
previous Gold Letter.] That Currie accepted the government's new
taper timeline within a month of being burned by the last shows
how little stomach they have for sticking to the fundamentals -
and how little accountability they face for getting it wrong.

Instead, major players like Goldman Sachs are betting their books
on the government's fearless bluff. In the eyes of Wall Street,
the economic indicators support this conclusion - inflation is
subdued, GDP is growing!

The Bluff Exposed

I've been an outspoken critic of this official data for years.
Over the course of my career, I have witnessed the government
dramatically change the way it calculates inflation, GDP, and
other statistics. While Washington's latest figures show a
year-over-year CPI increase of just 1.2%, the private service
ShadowStats, which recalculates the data along the lines that the
government used to, finds that real consumer inflation is closer
to 9%.

My guess is the true number lies somewhere in between, but that
it would be much higher were the US not able to export much of
its inflation abroad. The process works as follows: the Fed
prints money (inflation) and uses it to buy Treasuries and
mortgages. The government and banks, in turn, pass much of that
money to consumers, who spend it on imported goods. The money
then flows to foreign manufacturers of those products, who then
sell it to their own central banks, who print their own
currencies (inflation) to buy it. This money goes out to pay
wages, rents, etc., which the recipients then spend on goods
& services. Finally, the foreign central banks use the
dollars they buy to purchase US Treasuries and mortgages,
starting the cycle again.

It's a complicated relationship, but the end result is that
inflation created in the US ultimately bids up consumer prices
abroad and Treasury prices at home. In other words, our trading
partners have to pay much more for goods & services while
Americans get to borrow limitless money for next to nothing. The
products our trading partners "sell" us increase the supply of
goods available to American consumers while simultaneously
decreasing the supply available to everyone else. That is what I
mean by "exporting inflation," and the important thing to
remember is that its result is to mask inflation at home and
transfer wealth from emerging markets to the US.

The bluff gets worse. These understated CPI numbers distort real
GDP, which would be lower if the true inflation rate were
applied. The GDP calculations also include items like government
expenditures, which are possible only because of money printing
and not a result of any real economic production. Again, compare
the official figure of 1-2% GDP growth in the second quarter of
2013 to ShadowStat's figure of negative 2%.

If investors can't bring themselves to question official data,
there's another way to see through the government's bluff: look
to foreign central banks, which are actively preparing for the
day when the dollar is no longer the world's reserve currency.

The Bank of Italy recently affirmed that its gold reserves are
essential to its economic independence, while the World Gold
Council reported that this past year, European central banks held
onto more of their gold reserves than ever before. China, the
largest holder of US debt and the biggest consumer of gold in the
world, has started openly talking about ending the dollar's
reserve status. And while we don't know the total gold reserves
of the Chinese government, there are signs that they are
stockpiling.

Even US Treasury officials admit that the US will never sell its
gold reserves to deal with debt obligations. One spokesperson
said, "Selling gold would undercut confidence in the US both here
and abroad, and would be destabilizing to the world financial
system."

Time to Cash Out

So, who should investors believe about gold? Wall Street bankers
who directly benefit from asset bubbles created by the Fed's
inflationary stimulus?

No, it's time for individual investors to leave the table and
redeem their chips. Just remember - the longer you wait to cash
out of the US dollar, the less you're going to get for your
winnings.